why an October selloff?
the old days
Before the rise of the mutual fund industry in the 1980s, big investing institutions–banks and insurance companies–used to do annual tax planning in November-December–because their tax year ended in December. They’d reshape their investment portfolios and dump unsuccessful holdings so that realized losses could be used to offset otherwise taxable income. The key word here is “selling,” made more intense by the end-of-year timing. The exact starting day of the resulting market downturn was the subject of intense jockeying by the major players. Once someone started selling, though, everyone else jumped in.
For mutual funds, which today dwarf the activities of those former giants, the crucial months are September-October (more detail on why). In most years since the late 1980s there has been a several-week, tax-related selloff during this time, triggered by mutual fund tax planning. It’s typically been followed by a significant bounceback as selling pressure abates.
I think this is what has been going on in domestic markets for the past week or so. If I’m correct, selling will abate at worst in about two weeks–if for no other reason than that firms will try not to do trading during the final week of their fiscal year (to avoid having unsettled transactions hanging over into the new fiscal year). At best, I think, selling pressure will begin to ease up by the end of this week.
the role of IT
As I see it, the selling so far has been the most intense in the IT sector. Within tech, medium-sized companies that have been sharp outperformers so far in 2018 have been hurt the worst. Again, if my diagnosis of what’s going on now is correct, this last group is where the best buying opportunities will lie.
An unusual twist: a main goal of the selling this year seems to be for funds to reduce their exposure to IT and to the new Communication Services sector. Typical selling is more across the board. Two factors are likely at work: managers think their IT overweights have grown too large and are trimming them back; and they perceive greater relative value in other sectors. My guess is that the first is the larger influence.
Long-term Treasury bond yields have risen by about 70 basis points so far this year (10bp of that during the past week). The 10-year yield now stands at 3.19%; the 30-year is at 3.35%. At some point such yields will provide competition for stocks, particularly in the minds of Baby Boomers seeking steady income. This is a very important issue, especially since the US market hasn’t been in a position where this might matter since the mid-1980s. Nevertheless, I don’t see this as the main force behind current selling.
what to do
My experience is that most people, including many (most?) professional money managers, either turn off their quote machines or hide under their desks during market declines. Financially, a better strategy is to try to upgrade portfolio holdings. Clunkers that have never gone up will likely be temporary pillars of strength. On the other hand, stocks with much stronger fundamentals will be sold off mostly for tax or internal portfolio structure reasons. Trend-following short-term traders will magnify this difference. Anyone with a longer investment horizon should sell inhabitants of the portfolio dustbin and buy stocks they’ve wanted to own but which always seemed too expensive or to have had too much short-term upward momentum.
In my case, I’m mostly rearranging my holdings within tech …but that’s just me.
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